Tax Court Reinforces Scrutiny of Micro-Captives in Jones v. Commissioner

In another significant ruling addressing micro-captive insurance arrangements under Internal Revenue Code §831(b), the US Tax Court reinforced its position in Jones v. Commissioner of Internal Revenue, T.C. Memo 2025–25. This latest decision highlights the court's ongoing scrutiny of such arrangements, emphasizing the necessity for taxpayers to carefully adhere to established legal and actuarial requirements when utilizing captive insurance. 

STW, initially a distributor of high-purity process components, transitioned into manufacturing and sought additional insurance coverage beyond its traditional commercial policies. CSI, owned by STW executives Richard Shor and Sherry Maxson, elected to be taxed under Internal Revenue Code §831(b), allowing it to be taxed solely on its investment income and thus exclude received premiums from taxable income. To purportedly achieve risk distribution—a requirement for valid insurance—CSI participated in the OMNI reinsurance pool, ceding premiums and quickly receiving similar amounts back through retrocession agreements. 

The Internal Revenue Service (IRS) challenged this arrangement, disallowing STW's deductions for insurance premiums paid to CSI and CSI's exclusion of those premiums from income. The Tax Court concurred, ruling the arrangement did not constitute legitimate insurance due to a lack of genuine risk distribution, circular flow of funds, and premiums set without actuarially sound methods or arm's-length standards. Additionally, the court characterized a $400,000 payment from CSI to Shor not as a bona fide loan but as a constructive dividend, effectively determining that the payment represented a distribution of corporate earnings to Shor rather than a genuine debt obligation. 

Consequently, the court upheld the IRS's determinations, resulting in disallowed tax benefits claimed by STW and CSI for the tax years 2015 and 2016.